Week 4

Rather than acquire an existing machine parts manufacturer in Mexico, Robertson Corp., based in Ohio, chose to establish new operations in a northern Mexico city. This form of FDI is called a greenfield investment.

Explanation FDI takes on two main forms. The first is a greenfield investment, which involves the establishment of a new operation in a foreign country. The second involves acquiring or merging with an existing firm in the foreign country.

A high-fashion clothing firm from the United States invests in a fabric processing plant in Indonesia. This is an example of foreign direct investment.

Explanation Foreign direct investment (FDI) occurs when a firm invests directly in facilities to produce or market a product in a foreign country.

The management team at Pass the Ketchup Brands has decided not to license its product because of concerns that this will create opportunities for another company to have access to their secret recipe. For this reason, the company decides that FDI is their best course of action. Which economic theory does their choice represent? internalization theory

Explanation A branch of economic theory known as internalization theory seeks to explain why firms often prefer foreign direct investment over licensing as a strategy for entering foreign markets (this approach is also known as the market imperfections approach). It argues that firms prefer FDI over licensing to retain control over know-how, manufacturing, marketing, and strategy or because some firm capabilities are not amenable to licensing.

The market imperfections approach seeks to explain the preference for FDI over licensing by firms as a strategy to enter foreign markets.

Explanation A branch of economic theory known as internalization theory seeks to explain why firms often prefer foreign direct investment over licensing as a strategy for entering foreign markets. This approach is also known as the market imperfections approach.

The interdependence between firms in an oligopoly leads to imitative behavior.

Explanation A critical competitive feature of oligopolistic industries is interdependence of the major players. By cutting prices, one firm in an oligopoly can take market share away from its competitors, forcing them to respond with similar price cuts to retain their market share. Thus, the interdependence between firms in an oligopoly leads to imitative behavior; rivals often quickly imitate what a firm does in an oligopoly.

Yum Tum, a brand of low-fat yogurt, launched a drinkable yogurt. Immediately after this, another brand, Looking Good, also announced the launch of a new drinkable yogurt. Then Spoon Fulls, a third brand of yogurt, reduced the price of its product. What is most likely to happen in this oligopolistic market setup? Yum Tum and Looking Good will reduce the prices of their respective drinks.

Explanation A critical competitive feature of oligopolistic industries is interdependence of the major players. By cutting prices, one firm in an oligopoly can take market share away from its competitors, forcing them to respond with similar price cuts to retain their market share. Thus, the interdependence between firms in an oligopoly leads to imitative behavior; rivals often quickly imitate what a firm does in an oligopoly.

Three South American countries enter into an agreement to remove all tariffs and trade barriers between them. They decide on a common external trade policy and charge the same tariffs. Which level of economic integration best describes this arrangement? customs union

Explanation A customs union is a group of countries committed to (1) removing all barriers to the free flow of goods and services between each other and (2) the pursuit of a common external trade policy.

Firms for which licensing is not a good option include those that have valuable know-how.

Explanation Although licensing may work, it is not an attractive option when one or more of the following conditions exist: (1) the firm has valuable know-how that cannot be adequately protected by a licensing contract, (2) the firm needs tight control over a foreign entity to maximize its market share and earnings in that country, and (3) a firm's skills and capabilities are not amenable to licensing.

Governments impose quotas to limit importing.

Explanation By placing tariffs on imported goods, governments can increase the cost of exporting relative to foreign direct investment and licensing. Similarly, by limiting imports through quotas, governments increase the attractiveness of FDI and licensing.

Establishment of the euro required participating national governments to sacrifice national sovereignty for the greater good.

Explanation Establishment of the euro was an amazing political feat with few historical precedents. It required participating national governments to give up their own currencies and national control over monetary policy. Governments do not routinely sacrifice national sovereignty for the greater good, indicating the importance that the Europeans attach to the euro.

How many trade blocs are in Europe? two

Explanation Europe has two trade blocs—the European Union and the European Free Trade Association.

Kitchen Supply Corp. produces its entire line of restaurant-grade kitchen utensils and serving dishes at its manufacturing facility in the United States and then ships its products to various companies in Europe to sell. Kitchen Supply Corp. is involved in exporting.

Explanation Exporting, as opposed to importing, involves producing goods at home and then shipping them to the receiving country for sale.

A current account surplus is favored over a deficit. If a country is faced with a current account deficit it would have to __________ in order to support this situation. sell assets to foreigners

Explanation Governments typically prefer to see a current account surplus rather than a deficit. The only way in which a current account deficit can be supported in the long run is by selling assets to foreigners. For example, the persistent U.S. current account deficit since the 1980s has been financed by a steady sale of U.S. assets (stocks, bonds, real estate, and whole corporations) to foreigners.

Clear the Way Glass, a leading manufacturer of heavy, oversized glass blocks in the United States, is considering exporting as its FDI strategy. Exporting may not be a good option for Clear the Way Glass because of the glass blocks' low value-to-weight ratio.

Explanation Heavy glass blocks would have a low value-to-weight ratio. When transportation costs are added to production costs, it becomes unprofitable to ship some products over a large distance. This is particularly true of products that have a low value-to-weight ratio and that can be produced in almost any location.

The __________ committed European Community members to adopt a common currency by January 1, 1999. Maastricht Treaty

Explanation In February 1992, European Community members signed the Maastricht Treaty that committed them to adopting a common currency by January 1, 1999.

What is the most popular form of regional economic integration, accounting for almost 90 percent of regional agreements? free trade agreements

Explanation In a free trade area, all barriers to the trade of goods and services among member countries are removed. Free trade agreements are the most popular form of regional economic integration, accounting for almost 90 percent of regional agreements.

Two neighboring countries have the same wage rates, tax regimes, and business cycles. In addition, the two countries have reacted similarly to past economic shocks. These two countries can adopt a common currency because they form a(n) optimal currency area.

Explanation In an optimal currency area, similarities in the underlying structure of economic activity make it feasible to adopt a single currency and use a single exchange rate as an instrument of macroeconomic policy.

The Argentinian government decides to offer tax concessions to foreign companies that agree to build a manufacturing facility in Argentina. This tax concession is a way to encourage inward FDI.

Explanation It is common for governments to offer incentives to foreign firms to invest in their countries. Such incentives take many forms, but the most common are tax concessions, low-interest loans, and grants or subsidies.

Within a(n) __________, there is a level of economic integration that involves the use of a common currency, harmonization of members' tax rates, and a common monetary and fiscal policy. economic union

Explanation Like the common market, an economic union involves the free flow of products and factors of production between member countries and the adoption of a common external trade policy, but it also requires a common currency, harmonization of members' tax rates, and a common monetary and fiscal policy.

Michelin and Goodyear compete against each other not only in the United States, but also all across Europe and Asia. These two tire companies are engaged in multipoint competition.

Explanation Multipoint competition arises when two or more enterprises encounter each other in different regional markets, national markets, or industries. Economic theory suggests that rather like chess players jockeying for advantage, firms will try to match each other's moves in different markets to try to hold each other in check.

Where has the movement toward regional economic integration been most ambitious? Europe

Explanation Nowhere has the movement toward regional economic integration been more ambitious than in Europe. On January 1, 1993, the European Union formally removed many barriers to doing business across borders within the EU in an attempt to create a single market. By 2019 the EU had a population of more than 500 million and a gross domestic product of $19 trillion, making it second only to the United States in economic terms.

While the countries of Canada and Mexico are committed to removing all barriers to the free flow of goods and services between each other, they are independent in their trade policy dealings with other countries. This represents a(n) free trade area.

Explanation Several levels of economic integration are possible in theory. From least integrated to most integrated, the levels of economic integration are a free trade area, a customs union, a common market, an economic union, and, finally, a full political union. In a free trade area, a group of countries are committed to removing all barriers to the free flow of goods and services between each other but pursue independent external trade policies.

The __________ is one reason a company might prefer FDI over exporting. presence or threat of trade barriers

Explanation Some firms undertake foreign direct investment as a response to actual or threatened trade barriers such as import tariffs or quotas. The desire to reduce the threat that trade barriers might be imposed is enough to justify foreign direct investment as an alternative to exporting.

The European Union is considered a(n) __________ even though not all members have adopted a common currency. economic union

Explanation The EU is an economic union, although an imperfect one because not all members of the EU have adopted the euro, the currency of the EU; differences in tax rates and regulations across countries still remain; and some markets, such as the market for energy, are still not fully deregulated.

The __________ has a monopoly in proposing European Union legislation because the council cannot legislate without its permission. European Commission

Explanation The European Commission has a monopoly in proposing European Union legislation. The commission makes a proposal, which goes to the Council of the European Union and then to the European Parliament.

The European Free Trade Association initially consisted of member nations that decided not to be part of the European Community.

Explanation The European Free Trade Association (EFTA) was founded by those Western European countries that initially decided not to be part of the European Community (the forerunner of the EU). Its original members included Austria, Great Britain, Denmark, Finland, and Sweden.

One result of the Single European Act was that it provided the impetus for the restructuring of substantial sections of European industry.

Explanation The Single European Act provided the impetus for the restructuring of substantial sections of European industry. Many firms have shifted from national to pan-European production and distribution systems in an attempt to realize scale economies and better compete in a single market.

ASEAN has two objectives: foster free trade among member countries and achieve cooperation in __________ policies. industrial

Explanation The basic objective of ASEAN is to foster freer trade among member countries and to achieve cooperation in their industrial policies. Progress so far has been limited, however.

Direct effects of FDI on employment in the host country arise when a foreign MNE employs a number of host country citizens.

Explanation The effects of FDI on employment are both direct and indirect. Direct effects arise when a foreign MNE employs a number of host-country citizens. Indirect effects arise when jobs are created in local suppliers as a result of the investment and when jobs are created because of increased local spending by employees of the MNE.

Which situation represents an indirect effect of FDI on employment in a host country? The employees of Seven Sons Inc. have more money to spend and as a result, more home construction jobs are being created in the country.

Explanation The effects of FDI on employment are both direct and indirect. Indirect effects arise when jobs are created with local suppliers as a result of the investment and when jobs are created because of increased local spending by employees of the MNE.

A possible effect of FDI in the form of a greenfield investment in a host country is that it drives down prices and increases the economic welfare of consumers.

Explanation The efficient functioning of markets depends on an adequate level of competition between producers. When FDI takes the form of a greenfield investment, the result is to establish a new enterprise, increasing the number of players in a market and thus consumer choice. In turn, this can increase the level of competition in a national market, thereby driving down prices and increasing the economic welfare of consumers.

Liza told the management team that investing capital in the Chilean-based manufacturing plant would not only benefit their company in terms of labor costs but would also promote significant economic development in Chile. What type of host-country benefit is Liza referring to? resource-transfer effect

Explanation The main benefits of inward FDI for a host country arise from resource-transfer effects, employment effects, balance-of-payments effects, and effects on competition and economic growth. In regard to resource-transfer effects, foreign direct investment can make a positive contribution to a host economy by supplying capital, technology, and management resources that would otherwise not be available and thus boost that country's economic growth rate.

Pure Valley Foods currently has $470,000 in foreign-owned assets. This represents the __________ of the company. stock of FDI

Explanation The stock of FDI refers to the total accumulated value of foreign-owned assets at a given time

As a result of the formation of a free trade area between six member countries in the Pacific Rim, one member country found that its lower-cost external suppliers were replaced by higher-cost suppliers within the free trade area. This is an example of trade diversion.

Explanation Trade diversion occurs when lower-cost external suppliers are replaced by higher-cost suppliers within the free trade area. A regional free trade agreement will benefit the world only if the amount of trade it creates exceeds the amount it diverts.

The country of Turkey has lobbied for EU membership for many years but full membership has been denied because of concerns over human rights issues.

Explanation Turkey, which has long lobbied to join the union, presents the EU with some difficult issues. The country has had a customs union with the EU since 1995, and about half its international trade is already with the EU. However, full membership has been denied because of concerns over human rights issues.